OECD secretariat

1

Investment Regulation of Pension Funds in OECD
countries

• Juan Yermo
• OECD Administrator

2
The OECD study on Investment regulation

• What is the role of investment regulation?
• conflicts of interest (fraud, X-inefficiency) -
  investors as principals
• moral hazard of government guarantees
• specific government objectives (debt financing,
  social investing, corporate governance,
  macrostability, savings)
• What side-effects can investment regulations
  have?
• Diversification and performance
• Capital market imperfections
• What determines asset allocation and performance
• Regulations (governance, funding, investment,
  performance, etc)
• Type of plan and individual choice
• Pension fund liabilities (maturity)
• Local savings and investment culture
• Macroeconomic performance

3
Two main approaches to Investment Regulation

• Regulation of investment decisions
• traditional quantitative portfolio approach
• different types
• list of admissible assets
• minimum diversification requirements
• global asset allocation limits (by liquidity,
  credit risk, asset class)
• ownership concentration limits
• Regulation of investment decision-making
• prudent person approach
• governing structure and representation
• fit-and-proper requirements
• responsibilities - duty of prudence, SIP,
  disclosure
• member rights - information, representation,
  portability, and litigation
• legal implementation
• common law
• civil law

4
Quantitative Rules in the OECD

• Used in most OECD countries to
• limit self-investment (all between 0 and 30)
• ensure minimum diversification (single
  security/issuer)
• limit investment in property
• Used in some OECD countries to
• limit investment in equities and other higher
  risk assets
• limit investment in foreign securities (non-OECD)
• prevent excessive concentration of share
  ownership
• Used rarely in OECD countries to
• ensure minimum investment in government bonds
  (France only)
• limit use of derivatives (but hedging purposes
  rule common)
• but in general lighter than for life insurance
  companies

5
Self-investment limit ( assets)
6
Limit on investment in equities ( assets)
7
The Prudent Person Rule

• Section 404(a)(1)(B) of ERISA requires that a
  fiduciary
• discharges his duties with respect to a plan
  solely in the interest of the participants and
  beneficiaries and
• (B) with the care, skill, prudence, and diligence
  under the circumstances then prevailing that a
  prudent man acting in a like capacity and
  familiar with such matters would use in the
  conduct of an enterprise of a like character and
  with like aims.
• Courts and DOL regulations have clarified the
  rule
• there has been a thorough consideration of the
  issues
• there has not been blind reliance on experts.
• the fiduciary did not ignore or fail to
  investigate any relevant facts that would have
  altered the decision taken.

8
The Prudent Person Approach in the US

• The prudent person rule is based on three main
  concepts
• Duty of Prudence
• Exclusive purpose rule
• Duty to diversify
• But it is supported by a range of governance and
  investment regulations stemming from ERISA, DOL,
  and court resolutions
• Trustee fit-and-proper conditions
• Conflicts of interest regulation (including 10
  self-investment limit)
• Independence of custodians
• Reporting and disclosure rules
• Individual right of action/litigation

9
The Prudent Person Approach in the UK

• Self-regulation in the UK up to 1995 Pensions
  Act
• Duty of skill and care on trustees
• But until 1995
• No self-investment limits
• No independent custodians
• Few disclosure requirements
• No minimum funding requirement
• Main consequences
• Few incentives for fund managers to overperform
  (herding)
• Lack of internal funding controls (Maxwell
  1992-4)
• 1995 Pensions Act has corrected these failings
• Member-nominated trustees
• SIP, 5 self-investment limit, and third-party
  admin rules
• Minimum Funding Requirement (annual funding
  certificates)
• Disclosure trustees to members and auditors
  actuaries to OPRA

10
The Prudent Person Approach in other EU
countries

• Regulation of pension fund governance in the
  Netherlands
• Investment policy pursued should be sound and
  transparent and based on diversification of
  assets
• Equal representation of employers and employees
  (trade unions)
• Self-investment limit of 5
• Minimum funding rule
• Standardised actuarial rules to permit full
  portability
• Annual, comprehensive disclosure
• Broad supervisory and sanctioning powers (from
  1999 supervisor can test board members
  suitability and disqualify people)
• The EU draft directive is based on a similar
  approach
• testing the responsibility, competence, and
  integrity of managers
• effective supervision of prudential (e.g.
  self-investment, MDR) and disclosure requirements
  (SIP, actuary and auditor certification)
• use of modern diversification and ALM techniques

11
Selected OECD Principles

• Regulatory policies for employer/occupational
  pension plans
• Strict enforcement of an institutional and
  functional licensing system on the basis of
  adequate legal, accounting, technical, financial,
  and managerial (competence and honourability)
  criteria
• Strict limitations on self-investment, unless
  appropriate safeguards exist
• Liberalisation of investments abroad subject to
  prudent management objectives
• Transparent accounting methods based on
  comparable standards
• Enhancement of on-going supervision of the funds,
  including through the transmission of information
  to the authorities
• Setting up standards for adequate information and
  disclosure to the beneficiaries
• Promotion of self-regulatory practices for asset
  managers
• Levelling of the playing-field among operators

12
Selected OECD Principles

• Principles for the Regulation of Investments by
  pension funds
• The regulation of investments must
• simultaneously pursue the twin goals of security
  and profitability
• be integrated in the overall approach to ensure
  the financial soundness of the fund
• incorporate both institutional and functional
  considerations
• find adequate balance between external rules and
  internal controls
• Strict adherence to basic principles irrespective
  of instrument (quantitative restrictions and/or
  prudent person rules)
• Diversification and dispersion
• maturity matching (including the liquidity
  principle)
• currency matching, in the broad sense
• Recommendations relating the application of
  quantitative rules
• No minimum level of investment
• limits on self-investment and minimum
  diversification requirements
• list of admitted/recommended assets

13
Pension funds in the OECD
14
Equity investment by pension funds 1980-1998
15
Investment in foreign securities (1997)
16
(No Transcript)